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Monthly Archives: February 2008

The profit motive is not a prime cause of competent performance, writes Ted Black

WHEN the Soviet empire collapsed and capitalism became the only game in town, the “greed is good” doctrine took hold with a vengeance. It fuelled the 1980s boom and the dotcom bubble that followed. In turn, this led to the Enron and WorldCom scandals among many others. Now a key public concern is how to regulate roller-coaster stock exchanges and the corporations listed on them.

Driving through the Dimension Data campus reminds us that SA has its share of unbridled capitalists. Didata’s top management palmed its flawed “new economy” business model onto a gullible, investing public. Despite the marketing “spin” coming from the top today, its managers generate a return on assets of only 8%. That accomplishment is still around R2bn short of making an economic profit — probably something many IT people don’t even know about let alone measure.

The names of buildings on the campus —the Wanderers, the Gabba and Roland Garros —remind us how useful sporting analogies can be for the game of business. The trouble is that many of us have lost the concept of sportsmanship. When it comes to values, managers tend to model themselves on professional sportsmen and that’s a bad thing.

In 2004, after a 17-year study with 72 000 interviews, Prof Sharon Stoll at the Centre for Ethics at the University of Idaho in the US concluded that sport is good for “teamwork, loyalty, self-sacrifice, work ethic, and perseverance ” — all the “passion” and “commitment” stuff you see in annual reports. However, when it comes to “honesty, fairness, and responsibility ”, professional sportsmen are lousy models. Stoll ends her study concluding that sport today is about winning at all costs. With the notable exception of people like Adam Gilchrist — Australia ’s great wicketkeeper who walks when he knows he’s out —the driving value is “how to get away with it”.

It’s little different for many in corporations and the government. The price-fixing in the bread industr y followed closely on the Mittal fine. Next we have the dairy men accused of running a cartel, and skulduggery in the furniture business. Finally, Tiger Brands is under the spotlight again with Adcock Ingram’s pharmaceutical products. They all highlight issues of great concern.

Free-market ideologues argue that the relentless pursuit of greed and acquisition leads to best outcomes for society. In other words, the “profit motive” is a prime cause of competent performance. Another belief is that organisations with the best talent, rewarded with lavish compensation, will outperform their competitors. They are myths.

Dr Tom Gilbert wrote a masterful book on the subject of performance management in 1978. Pulling no punches, he argued that the subject of motivation arouses more nonsense, superstition and plain self deception than any other topic. Two kinds of incentive on offer are money and the other ways we recognise people for good work. The most powerful lever of all is money. However, the truth is it has limited effect on productivity because it’s the hardest one to grasp. Moreover, the higher you go in an organisation, the more slippery it gets. Why is that?

It ’s because we confront a host of vested interests in incompetence. The issue becomes highly emotional and political. It’s about distribution of wealth: who do we reward with how much for what?

That’s why top executive pay is such a hot topic. There’s no positive correlation between money paid and competence. Top executive pay derives from one thing. Above all, the value of any firm links to its monopolistic position in the market segment it serves. This enables it to create high profits. These high profits come from being very good at what they do—a good thing—or in some cases collusion with competitors to fix prices —now illegal.

It also means that many powerful people who control company performance systems are not paid for managerial competence. If they were, a lot of them would be out of a job. That fear is a major barrier to the efficient use of money to reward worthy performance.

The power to set and control prices is the only power corporations need to ensure a self-fulfilling profit motive. Exhibit 1 shows some dominant players in SA and the relationship between return on sales (operating profit as a percentage of sales — ROS) and return on assets managed (operating profit as a percentage of assets managed —ROAM).

All the companies shown dominate their market sectors. With the exception of retailers Pick ’n Pay and Cashbuild who strive to sell at lowest price to customers, the rest aim to sell at as high a price as they can get.

The Vodacom and MTN numbers reflect their southern African segments and SAB numbers include ABI. I suspect that if SABMiller’s annual report were to show Beer SA on its own, with a ROS of at least 27% for beer, the ROAM will be higher than 100%. Sasol’s performance is tied to the oil price and PPC cement rides the economic wave. They can’t go wrong even when they performin a mediocre fashion —as do the telecom companies. That’s the power of monopolistic market share.

As to Tiger Brands, after its baking and milling operation was caught colluding with competitors, it used legal firm Edward Nathan Sonnenberg (ENS) to argue that “hands-on” CEO Nick Dennis knew nothing about the arrangement. It was not a good move. His claims of innocence coupled with the ENS study smacked of “he doth protest too much, methinks”.

ENS, known for its skill in running with the hares and hunting with the hounds, was discredited by the Nedbank deal it did at the height of the dotcom boom. That’s when “brains ” became “intangible” assets on company balance sheets. The deal probably cost the bank’s shareholders R1bn if you add in lost opportunity cost to the R500m paid to own these legal brains for five years.

When it comes to corporate governance — and ENS helped define the King Code —the firm’s reputation is spotty. Especially when you consider that it bought its brains back for a mere R50m.

Little has changed with lawyers and cartels it seems. A classic British Board of Trade study in the 1940s observed: “The variety of (cartel) arrangements is very striking and attests to the ingenuity of industrialists, or at least of the accountants and lawyers who advise them.” Given that some things change very little over time, how much collusion goes on among the companies on the chart? The telecoms industry and cement producers for instance?

As to the bread pricing issue, it will not go away. Moreover, it seems that some Tiger Brands executives are either unaware of their own numbers or do not understand what they mean. Exhibit 2 shows group segments at year-end 2006.

Pharmaceuticals, not surprisingly given the latest allegations of price collusion, had a 90% ROAM in 2006. The baking and milling division that sells bread, a consumer staple, achieved a 40% ROAM. It has just announced a further price increase to recover increased costs.

In contrast to Mittal, whose ROS dropped sharply after being fined— it fell from 30% to 25% —Tiger ’s bakers and millers have increased returns sharply over the past four years. The ROS has moved from 9,7% to 16%; an increase of 65% for a staple food. Exhibit 3 shows how well this division is doing.

The question is how much of the improvement can be attributed to the “continuous improvement” productivity programmes proudly described in the annual reports, or to price increases? That’s what Tiger Brands ’ corporate marketing effort should be explaining to the public, the shareholders and most importantly, the company’s employees.

Instead, the SABC website quotes Tiger ’s spokesman as saying: “The price increase is also to maintain employment. So which one is a better devil—to retrench a whole lot of people so that you can push down your labour costs, or cause more poverty and frustration to the poor?” So much for top management understanding and measuring the effect of productivity initiatives!

Corporate marketing should be 80% internal and only 20% to investors and analysts. Most companies get it the wrong way round. They learned to do that from narcissistic celebrity manager Jack Welch whose cost to society and the environment probably far outweighed his value. His greatest skill for GE’s shareholders was his ability to market himself and to manipulate Wall Street analysts, academics, the media, and the share price.

THE reality is that despite the high returns some companies deliver, their people perform incompetently for most of the time because of the systems they work in (confirmed by Tiger Brands’ defence of the price increase above). This incompetence inflates the costs of doing business. Top management, responsible for the design of the systems, then raises prices to cover them. Most of its talent is applied to developing strategies that make the price rises as invisible as possible.

When business slows, customers, especially the big and powerful ones, won’t accept the increases. That’s when the word goes out from the top: “Cut costs!” The message sent is that a higher level of incompetence is fine during boom times when customers can carry the cost burden. However, top management scores either way. When times get tough, after sacking thousands of people they are rewarded with plaudits from the analysts and healthy bonuses from remuneration committees.

In 2005, Boston Consulting Group published one of its brilliant “Perspectives ” on the issue of incentive compensation. Its authors, Andrew Dyer and Ron Nicol, started by asking: “How do you create a hunger for performance in your organisation without creating a greed for reward? Too often, in the pursuit of growth, we strike a dangerous bargain. We start with a promise: ‘I’ll pay you whatever it takes to meet these goals.’ Then we delude ourselves into thinking we can control the inevitable and spreading greed by installing tighter governance. But greed outsmarts governance. With bonuses at stake and promotions on the line, games get played and figures are faked. Not just accounting figures but also sales, delivery and return figures.”

The danger in all this — particularly in SA — is that capitalism won’t be the only game in town any longer if this situation continues. Tiger Brands’ CEO Nick Dennis will probably walk away with a package that would take the lowest paid worker in the company more than 3 000 years to earn. It’s nonsensical and dangerous.

The least known and most under-appreciated great man of the 20th century was the late Peter Drucker. Because of his focus on management, he probably had more influence on more people than any other writer in the last half of the century. He saw that corporations, with some special exceptions, had lost the communal spirit he first saw in General Motors during the 1940s when the workforce was making tanks and Jeeps for the war effort.

He argued that the first of two reasons for losing this spirit was that workers and employees were viewed as costs—not resources. It all comes down to treating them right. This means “releasing ” their energies to be the best at what they do. And secondly, that even in the 1980s executives were being overpaid when compared to the rank and file.

Finally, levering up margins through high pricing instead of productivity means firms define themselves in terms of the products they produce and not —as Drucker urged managers to do — the customers who buy them. In SA by far the majority of customers are dirt poor. That’s why capitalism driven purely by greed will destroy community and ultimately itself and the nation.

Sir Adrian Cadbury wrote in his book “Corporate Governance and Chairmanship. A Personal View” (Oxford 2002) that the character of a company is in its people’s hands. They inherit its reputation and standing and it is up to them to take them forward. One of his simple, admirable statements of aims was “nothing is too good for the public”.

Ted Black writes, coaches and conducts ROAM workshops that help managers design results-driven projects that grow them and their people.